Will Cisco’s Q3 results inspire a post-earnings share price bounce?

Technology giant Cisco hopes to secure its future through the acquisition of software companies. Will this give Cisco, and its share price, a timely boost as the world increasingly works remotely?

Cisco [CSCO], the global manufacturer and distributor of routers, switches, and data servers, is shifting its focus to software. The question as to how this pivot might affect the company’s share price will intrigue investors.

First established in 1984, the tech company’s core business has been the designing, manufacturing and selling of networking hardware and telecommunications equipment. And while the business has for some time made a portion of its revenues from software, it is now actively stepping up its game in the SaaS space - a sub-industry notorious for significant share price gains in recent history.

Over the past four years, Cisco has spent billions in acquisitions, buying up more than 30 companies in order to diversify and bolster its status as a key player in the software market. But with Q3 fiscal year 2020 earnings due to be released on 13 May, how might Cisco’s share price react as the pivot starts to take shape?

What’s happening with Cisco’s share price?

Cisco’s Q2 earnings were announced on 12 February, and although its report was somewhat negative both for the quarter and its future outlook, the numbers were better than analysts expected. Despite a 4% decline in revenue year-on-year to $12.01bn, Cisco just about managed to beat analyst expectations of $11.98bn. The same can be said for earnings per share, which were expected to be $0.76 but came in at $0.77 — a surprise of 1.32%.

It was the same story a quarter earlier, where the company was expected to post Q1 earnings per share of $0.81, but actually produced earnings of $0.84 per share, delivering a surprise 3.7% beat. So, how have those results gone down with Cisco’s share price investors, and the analysts that track it?

Over the last two quarters, that makes an average surprise of 2.51%. As a result, estimates for Cisco’s upcoming quarter have taken a favourable turn. The Zacks earnings expected surprise prediction for the Cisco’s share price is positive which, when combined with a solid Zacks Rank (currently a hold), is a good indicator of an earnings beat.

What drives Cisco’s share price?

Some of Cisco’s revenue growth in recent years is down to its acquisitions, according to Investor’s Business Daily, most of which have been software-related. In 2019, the company acquired six companies, including communications company Acacia for $2.6bn, as reported by Bloomberg. In 2017, Cisco also acquired software maker AppDynamics for $3.7bn and then BroadSoft for $1.9bn later that year.

With cash to spend, there’s an expectation that Cisco could buy more companies when the impact of the COVID-19 pandemic has settled and make the monumental, transformative acquisition that some analysts have been waiting for.

In a recent note to clients, Bank of America analyst Tal Liani said: "We believe Cisco is between (product) cycles now and may need to make a large-scale acquisition to make a more meaningful impact on the portfolio."

Cisco’s switch to software

Before the COVID-19 outbreak, Cisco stated that 30% of all revenue would derive from software during its 2020 fiscal year, up from 2017’s 22% figure.

Cisco’s timing couldn’t be better. While global corporate spending on information technology is expected to decrease overall by 4%, there has been a significant increase in demand for collaborative business solutions — such as Cisco’s Webex teams — as governments take drastic measures to fight COVID-19.

Although Cisco is yet to withdraw its 2021 fiscal guidance, Investor’s Business Daily reported that: “An increasing mix of recurring revenue from subscription-based services is key to the Cisco strategy.”

Despite Zoom [ZM] hogging the video communication platforms spotlight, there are concerns over its security. This could result in users, especially businesses, diverting to more secure platforms such as Webex.

“Cisco commands an edge when it comes to security and applications, two-division that continue to register double-digit growth. Likewise, the company remains well-positioned to register robust growth in the future as the COVID-19 pandemic continues to influence how people work,” MarketWatch recently noted.

What does this mean for Cisco?

According to Zacks, Cisco is expected to report earnings per share of $0.72, down 7.69% from the prior-year quarter. The consensus estimate is predicting quarterly revenue of $11.94bn, down 7.88% from the same time last year.

As for the full-year, Zacks Consensus Estimates calls for earnings of $3.06 per share (-1.29% YoY) and revenue of $48.89bn (-5.81% YoY).

Of the 27 analysts that track Cisco’s share price - polled by CNNMoney -, the consensus is to hold stock. This comes from a majority of 13 analysts, compared to 11 that gave a buy rating and another three that gave an outperform rating.

The same analysts have a median share price target of $46, but there are estimates that the stock could go as high as $60. These estimates would represent increases of 5.9% and 38% respectively for the closing price on Monday 11 May.